Savings and investments: when the guaranteed isn't guaranteed

Nervous savers like the security of a guarantee, but are they always watertight?

In these uncertain times, guarantees can look increasingly attractive to nervous investors.

Many investors may be keen to dip a toe back into the stock market, but with conditions still choppy, having an additional guarantee could help keep their savings afloat. But some advisers are warning investors they may be paying too much for protection that may not be watertight.

This issue hit the headlines again after the collapse of investment firm Keydata. It sold thousands of structured products (often known as Guaranteed Equity Bonds, or Gebs) that promised investors stock market-linked returns without putting their capital at risk.

Although it now seems unlikely that any Keydata customers will lose money, investors had an anxious few days once it emerged the firm had gone bust. Although Keydata primarily sold guaranteed investments, it wasn't the terms of these guarantees that got the company into difficulties. It ran into trouble after it failed to set up thousands of Isas correctly, leaving the firm with a huge tax bill.

But this demonstrates the first thing investors should consider when buying a guaranteed product: the promise is only as good as the company making it. If it runs into unrelated difficulties, your money still could be at risk. Below are five items investors should consider before buying a guaranteed product.

1. A guarantee is only as good as the guarantor

This may be common sense to a certain degree, but, until recently this aspect was often overlooked. Banks may guarantee to keep your money safe, your employer may guarantee to pay you a set pension on retirement, and an annuity provider guarantees to pay you a fixed income for life. But if the bank goes bust, your employer goes under or an insurance company collapses then all bets are off.

With any investment ask whether money is ring-fenced from company finances. This happens automatically with pensions, for example, and should give you extra protection if the firm administering the investments gets into trouble.

Consider where you are investing your money. Has the company got a good track record, and do you expect it to be around in future? How easy is it to contact the company should problems arise?

Does it have high street branches and call centres, or are you reliant on just an internet site? As recent history demonstrates, a well known name does not protect against failure.

2. Is there a counterparty risk?

Unfortunately, those buying guaranteed investments don't just have to weigh up the likelihood of the company selling them going bust, and therefore reneging on their promise.

Many of these products are underwritten by third parties – usually large investment banks. If one of these gets into difficulties your money could be at risk, even if the company that sold it to you continues to trade profitably.

This problem was highlighted by the collapse of Lehman Brothers, which acted as a "counterparty" guarantor on a number of structured products sold to British investors. This bank was one of five investment banks backing a couple of Legal & General (L&G) products, for example (both of which were sold through Bradford & Bingley and Alliance & Leicester branches).

Like Gebs, these products promised returns linked to the equity market or your money back at the end of the term.

But as Lehman can't honour this guarantee, investors could lose up to 20pc of their capital when these plans mature. L&G is not going to pay the difference, arguing that it was clear in product literature that if one of the investment banks listed got into trouble capital could be at risk.

Many advisers say investors would have been unaware of this risk. Saran Allott-Davey, the managing director of Heron House Financial Management, said: "These are complicated products that in many cases are unsuitable for the audience for which they were intended."

Most investors would think it is the company selling the investment, whose name is on the product, that is providing the guarantee. But this is often not the case, and it can affect customers' right to compensation if something does go wrong.

3. What are you paying for this guarantee?

Investors keen to grab the first available safety rope often overlook what they are being charged. Ms Allott-Davey said: "Investors need to be better educated about risk, so they can weigh up whether the cost of a guarantee is worth paying."

These costs can be explicit – on some pension products, for example, or unit trusts that offer a level of protection, there will be an annual management charge to cover the cost of this guarantee.

But charges can be less obvious. With Gebs, for example, most investors get a proportion of any rise in the linked stock market index, and they do not get any dividend payments at all, which account for a sizeable chunk of total equity returns. Missing out can cost investors dear.

And the costs of these guarantees can rise sharply if economic situations worsen. This has scuppered many guaranteed products in the past – and is one of the reasons why the US insurer, Hartford Life, stopped offering its guaranteed "third way" annuities to British customers.

4. Can a guarantee be altered later?

In theory this shouldn't happen, but if economic circumstances worsen companies may try to. Jason Walker, of advisers AWD Chase de Vere, said this is what has happened to millions of people who have contributed to final salary pension schemes.

Many workers were given an assurance they would receive a salary-linked pension, but have found themselves with a far smaller income in retirement, after their firm went bust.

Other companies have also changed pension terms, requiring staff to pay more, or – as Barclays did recently –closing their final salary pension.

Similarly, Equitable Life also tried to alter the terms of a guarantee, reducing bonus rates to effectively nullify the generous guaranteed annuity rates it promised many pension savers. The High Court forced Equitable to honour these guarantees, so the insurer closed its door to new business.

5. What is the fallback position?

Check what protection is available if the worst happens: a company fails and guarantees are not met. Could you claim from the Financial Services Compensation Scheme (FSCS) or another body?

As a rule of thumb, if a "counterparty" bank fails, you are unlikely to be entitled to any compensation.

The FSCS will pay out up to £50,000 for money saved in a UK bank or building society and £48,000 for an investment product. In addition, the FSCS will pay out 90pc of any pension or insurance claim (more information at www.fscs.org.uk). Those buying products from foreign-owned companies may have to first claim from an overseas compensation scheme.

Usually government guarantees are seen as the most watertight. But even here it is worth treading cautiously, as Icesave customers found out. The Iceland compensation scheme was unable to pay out after banking collapses in the country. British savers only got their money back when the British Government stepped in.